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Re-blogged post: Are Americans spendthrifts?

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Are Americans spendthrifts?:

savings_rate.png

Low savings rate: The "personal savings rate" was 10% in the 70's; but, it fell to a low of 2% recently.

"Wealth Effect" / Confidence in the future: Take a closer look at the chart. The savings rate rose a bit in the 1970s, compared to the 1960s. The 70's were an economically-troubled decade. When people feel less certain about their future, and when they feel their wealth has been eroded, they try to save more. This is a rational response. Perhaps this explains the slightly increased savings rates of the 1970s'. The chart then shows a drop in the savings rate starting in the early-1980s. Could this be because people felt better about their wealth and about their future?

saving_wealth.pngThis second chart also shows Personal Wealth as a multiple of current GDP. I chose this as a very rough proxy for how wealthy the "average person" feels. In the early 1960's wealth was over 3 times GDP (see the right-side axis). By 1975, wealth had dropped under 3 times GDP while the savings rate rose .

Then, wealth came back to about 3.5 times GDP and the savings rate dropped back. Around 1995, we see wealth rising (taking in its stride a short, sharp drop for the "dot.com bust") till it was over 4.5 times GDP before our recent "housing bust". Meanwhile, the savings rate plunged.

Wealth and GDP are both expressed in nominal dollars (i.e. not adjusted for inflation). When the prices of long-held assets (like the stock market or home prices) go up, nominal wealth rises. Feeling richer, many people figure they're saving enough. Clearly, many people did not anticipate the sharp fall in asset valuations of the current recession. (This is different from outright profligacy or spending regardless of one's level of wealth.)

Stimulus dampens savings:

Government stimulus cushions blows and redistributes losses. In the short run, there is less urgency to act. The reduced urgency must surely mean people save less. A person who thinks "this will blow over in a year or two" will have less urgency compared to someone who thinks we will have a decade-long slowdown. Similarly, if fiscal and monetary stimulus keep the stock market and home prices from falling even lower, it raises the nominal value of wealth without increasing real wealth. This creates a false sense of comfort. In this sense, worse news would have been better news. More accurately, if people understand how bad things are, they are more likely to act to fix things (Note 1).

Consider the dot.com bust of 2001. The chart shows relative wealth dropping, and saving rising slightly. Then,

Greenspan rode in to save the day by lowering interest rates and championing equity-extraction, creating the housing bubble. Rising home prices meant rising wealth and the saving rate dipped again.

Next up, a turning point? Now look the the extreme right of the chart. We see the savings rate bottomed around 2%, but has since turned upward (left-hand side axis). The recent recession has unsettled many people. People are saving a little more than they were doing a few years ago, bringing the rate up to 5%. it is hard to say where this will go. If the fiscal and monetary stimulus keeps asset prices up, we might see less worry and the saving rate may not increase as much as needed.

On the other hand, if the economy slows -- as it seems it will in 2012 -- wealth may flat line or even fall and people will probably save more.

So are Americans spendthrifts? Clearly that are many people who live beyond their means. However, this anecdotal evidence is not necessarily representative. Since 50% of credit-card holders claim to pay their bills in full each month, perhaps there are just as many people who are conservative about money, as not. Perhaps people living through the dot.com boom and the housing boom should have realized that we're in something of a "relative boom" (i.e. it looks like a bottom, but only because the bungee cord of government-spending kicked in). However, thinking "this time is different" is not quite the same thing as wanton profligacy.

Summary: Americans have not been saving enough, partly because they were carried away by the enthusiasm of a multi-decade credit-driven boom. They have now begun to save a wee bit more, but still not enough.

Caveat: Other factors play a role in determining the rate of savings: demographics, interest-rates, rates of return ("factor productivity"). As the population ages, one would expect lower savings rates [retirement years are years when people spend wealth that was previously saved].

Note 1: This is like the metaphor of a "spring" used by George Reisman. Often, things seem to "spiral downward", but the process is often like compressing a spring, which continues to gather more force to counter the downward move.

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Blog cross-posted with permission. See link at top of post for original.

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Also it makes little sense to save when inflation is higher than the nominal interest rate, resulting in a real negative interest rate.
It makes saving really tough if money is losing value even after interest is added in. With hyper-inflation all bets are off, but in a regular high-inflation scenario there will probably be some places one can save/invest to get some type of real appreciation over the long term. Over the medium and long term, I suspect the main driver of negative real rates is cramping of production rather than expansion of money.

There's something else that's interesting to contemplate. Supply of savings does not necessarily dry up if interest rates are too low, because people have to save in order to have money for retirement. Low positive real rates of return can actually induce people to increase their saving-rate to compensate, as they target a certain wealth-level for retirement.

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Supply of savings does not necessarily dry up if interest rates are too low, because people have to save in order to have money for retirement.

Not if they aren't expecting social security, and/or some other pension. Which many do. (Not a rational strategy, to be sure!)

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Not if they aren't expecting social security, and/or some other pension. Which many do. (Not a rational strategy, to be sure!)
I think you meant "are expecting".

I sometimes wonder about this: what are people actually expecting here? I don't mean what people say when they're talking casually. A lot of people say things like "social security is not going to be there for me". Yet, I suspect that they really don't think the impact on them will be that serious. One of the few things Rick Perry got right in the debates is when he called Social Security a Ponzi scheme. Romney -- with his MBA/focus group orientation -- shot him down. This tells me that people -- including a bulk of GOP primary voters -- don't think social security is going to be impacted too seriously. Otherwise, we should hear more from people than their musings that social-security will not be there for them. If voters are not politically-ready to tackle SS, it must be because they do not really think it is a serious enough problem.

I wonder if anyone has done a serious study into actual beliefs about social security.

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Not if they ...

I sometimes wonder about this: what are people actually expecting here?... ...I wonder if anyone has done a serious study into actual beliefs about social security.
I found one site (ebri.org) that has surveys about people's expectations regarding retirement. Their latest survey related to social-security is here.
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Feeling richer, many people figure they're saving enough.

It's the act of getting rich, not feeling rich, that diverted assets from savings to investment. If you look at returns, you see the stock market underperforming savings rates up until about 1983. Before that point, investing was a crap shoot, and the average person made more on savings than in the stock market. After 1983, the market entered a twenty-year boom during which DJIA returns far outstripped savings rates. The crash in 2001 led to a modest uptick in savings rates, and the crash in 2008 got people to reevaluate the risk of stock market investing, dramatically reducing its risk-adjusted expected return, and shifting assets back to risk-free savings.

Two other factors in recent upturn in savings rate is the increase in FDIC insurance from $100k to $250k (the first increase in almost 30 years), and the rapid increase in risk-averse, retiring baby-boomers. Retirees are more likely to shift assets into savings from investment as they liquidate and seek to reduce risks.

Edited by agrippa1
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